Estate Planning for Beginners – Part 2: How Assets are Passed

Estate Planning Part 2: How Assets are Passed
It may surprise a lot of people to discover how many individuals die without a will. In the not-too-distant past, this would include Prince, Michael Jackson, Howard Hughes, Salvatore Phillips “Sonny” Bono, and Jimi Hendrix, just to name a few.

When an individual dies without a will, state statutes will be used to determine who will inherit the assets that have no clear path to a beneficiary. These assets are controlled by the state. To learn more about what this means, we recommend reading Estate Planning for Beginners, Part 1.

How Assets are Passed

Assets may be in joint name, such as:

  • Joint tenants with “Right of Survivorship (JTWROS);
  • Joint tenants as “Tenants-In-Common”; or
  • Joint tenants as “Tenant by Entirety.” This form of tenancy is not available in all states and is only applicable between spouses. It also has creditor protection issues that can be especially important.

Assets may have beneficiary designations, such as:

  • Life insurance;
  • Retirement plans;
  • Annuities; and
  • Payable on death provisions (POD).

In each of the above cases, assets pass outside of the estate for “probate purposes” but not for tax purposes. In other words, regardless of whether one dies with or without a will, the form of ownership or the beneficiary designation will dictate how the asset will pass and to whom. It is the remaining assets in the sole name of the decedent or were applicable “joint assets as tenants-in-common” that are subject to distribution by the terms of the will or if there is no will, under the “Intestate Distribution” provisions of state statute.

As professional financial advisors, we think the assets, as noted above, are worthy of a will and possibly a trust. More to the point, anyone with assets should have a will, and when applicable, a trust. In the first scenario, with the first marriage and children of the marriage, it would not be unusual to have a will that leaves everything outright to the surviving spouse. In addition, and noting the age of the children, it would also be likely that the will would provide for a “testamentary trust” (where the trust is part of the will itself) at the very least for the benefit of the children until they reach a certain age or ages.

The selection of the age should be at a minimum a year or two beyond the completion of four years of postsecondary education. Unless there are reasons to the contrary, we typically use age 25 as the starting point. Past experience has shown that in a number of situations where the child received money much too early, in some cases as early as age 18, it was squandered before they turned 25. It is for this reason that we believe in split distributions for children such as 10 percent at age 25, half the balance at age 30, and the remaining balance at age 35. We would also recommend that if any document calls for actual distributions, the financial advisor speaks to the family and the attorney and instead of mandating distributions, a percentage of the funds is to “vest” in each child as the funds are available for distribution.

In this way, the child will have the unrestricted right to draw a certain percentage at a given age. If things are going well, the child can leave the funds in the trust and take them out at any time. In addition, if you think about this carefully, you’re providing a quasi-will for each child. If they don’t take the funds out, you would typically direct that if the child were to die with assets remaining in the trust, the funds would continue on for their children. If there aren’t any children of their own, then onto the client’s surviving children, per stirpes.

When clients come to us, if we discover they don’t have a will or a trust, or if their will is outdated, then creating or updating this document is the first item we address. Under normal circumstances, everything else can wait its turn.

An Example

Let’s take a look at two situations in the state of New Hampshire. In situation number one, there is a couple in their first marriage with two children ages six and eight. In situation number two, each partner is in their second marriage with each having a child from a previous marriage. Partner one’s daughter is six-years-old and partner two’s son is eight-years-old. Let’s disregard who should’ve owned the assets and concentrate on how they are actually owned. In both cases, partner one has a house in their name worth $200,000, investments of $500,000, and $250,000 of life insurance payable to partner two. In both cases, partner two has their own assets.

Now remember the assumption, partner one dies without a will in situation number one.

In the first situation, partner two gets $250,000 of assets and half of the balance. The two minor children inherit the other half equally and these assets will remain under the jurisdiction of the probate court for years until the children reach the age of majority. In other words, partner two will have to account to the probate court annually as to how they have handled the children’s assets. How exactly are these assets allocated?

First, the life insurance is easy and the $250,000 goes directly to partner two (due to the beneficiary designation naming them directly). The life insurance is not a probate asset and not subject to the intestate rules as it passes outside of the probate estate. Of the remaining balance of $700,000 (the house and the investments), partner two gets the first $250,000. That leaves $450,000 to be divided between the spouse and the children or about $225,000 to the spouse and $112,500 to each of the children. Is this what partner one would have done had they had a will? Probably not, and the complexity of having assets subject to probate court jurisdiction could have been avoided. Don’t underestimate the formalities and cost of having to deal with the court, annually.

Now, let’s look at the second situation:

Same assets and same ownership, still in New Hampshire. Second marriage with children from prior marriages. If the surviving spouse has a child who is not the decedent’s child, the surviving spouse receives the first $100,000 and one half of the balance of the estate if the decedent left children of their own who are not children of the surviving spouse.

As mentioned above, this happens much more often than clients or professional financial advisors would suspect. In fact, this contributes to why probate courts have such a terrible reputation, and this is simply because the testator (partner one in this example) never took the time to put in writing exactly who is to receive the money and assets and in what amounts. Regardless of whether the property consists of real estate, life insurance, annuities, IRAs, closely held business interest, or personal property, it makes a lot of sense to put together a will, at bare minimum.

The selection of the age should be at a minimum a year or two beyond the completion of four years of postsecondary education. Unless there are reasons to the contrary, we typically use age 25 as the starting point. Past experience has shown that in a number of situations where the child received money much too early, in some cases as early as age 18, it was squandered before they turned 25. It is for this reason that we believe in split distributions for children such as 10 percent at age 25, half the balance at age 30, and the remaining balance at age 35. We would also recommend that if any document calls for actual distributions, the financial advisor speaks to the family and the attorney and instead of mandating distributions, a percentage of the funds is to “vest” in each child as the funds are available for distribution.

In this way, the child will have the unrestricted right to draw a certain percentage at a given age. If things are going well, the child can leave the funds in the trust and take them out at any time. In addition, if you think about this carefully, you’re providing a quasi-will for each child. If they don’t take the funds out, you would typically direct that if the child were to die with assets remaining in the trust, the funds would continue on for their children. If there aren’t any children of their own, then onto the client’s surviving children, per stirpes.

When clients come to us, if we discover they don’t have a will or a trust, or if their will is outdated, then creating or updating this document is the first item we address. Under normal circumstances, everything else can wait its turn.

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